BP’s battles leave it vulnerable to major move

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If ExxonMobil chief executive Rex Tillerson really wanted to, he could snap up BP in a single bite. Of all the UK major’s rivals, Exxon, the world’s biggest energy company, has the firepower to swallow BP whole. Could it happen?

Some industry insiders think yes. Almost five years after the Deepwater Horizon disaster in the Gulf of Mexico, BP’s share price is languishing 30 per cent below where it was before the oil spill. BP’s total shareholder return has sharply underperformed those of its peers over the past decade.

The near-50 per cent tumble in oil prices since the summer — to $60 a barrel — makes BP vulnerable. Size is not everything, but it matters. The risk is that the latest round of cost cuts and asset disposals executed by BP chief executive Bob Dudley will shrink the company to the point where membership of the “big five” — an elite bracket of oil majors with the resources to develop the world’s biggest projects, is in doubt. That may make it a takeover target for Exxon.

“If you put BP and Exxon together, BP would bring a big inventory of deepwater development and exploration opportunities. That might be enough for Exxon to do a deal,” says one institutional investor.

Exxon, moreover, has said it is “alert” to bolt-on acquisitions. It could be a first mover.

BP would not be a mere bolt-on deal, but there is a logic to its acquisition by Exxon. Unlike its US rival, BP is stronger in America than elsewhere. It has enjoyed deepwater exploration success in the Gulf of Mexico. Add in attractive assets in Brazil and Angola and the two start to look a good fit. BP’s stake in Rosneft would hand Exxon Russian output just as its Arctic project with Rosneft has been frozen because of western sanctions. Moreover, the US company has a record for adding production through takeovers.

There could be other benefits. Exxon might navigate the US legal system more adroitly, keeping a lid on the legal bill stemming from Deepwater Horizon, which currently stands at $43.5bn. A takeover could lead to savings: Exxon absorbed Mobil efficiently in 1999. The same rationale — reduced fixed costs — would apply to a BP merger with Royal Dutch Shell, also cited as a possible buyer.

BP is much smaller than it was before the Gulf of Mexico incident, having sold more than half its pipelines, 35 per cent of its wells and 12 per cent of reserves.

That downsizing was necessary to meet the cost of the Deepwater Horizon clean up, as well as pay compensation to those affected and regulatory fines. And it is not alone in pursuing “value over volume” — an industry mantra for tackling soaring cost inflation that eroded profit margins at $100 a barrel for oil.

But the pace of contraction has been fast at BP, raising doubts over whether it would have the scale to compete for the big fields it needs to replace reserves.

Mr Dudley has not shied away from this challenge — but against a backdrop of falling oil prices, his immediate goal is to ensure that BP can sustain steady dividend payouts.

After announcing a slide in profits last year, this month he cut BP’s planned capital spending for 2015 by 20 per cent — a much steeper reduction than many rivals made.

Neill Morton, analyst at Investec, says BP is “hunkering down” for an extended period of lower oil prices. Assuming industry costs also decline, BP should in time cover its capital spending and dividends with cash flows.

That may demand a leap of faith, but Mr Dudley can point to the delivery of $32.8bn in operating cash flow in 2014, exceeding a target set three years ago. “Shareholders are going to have to rely on the promise of jam tomorrow. It helps that BP have got credentials,” says one investor.

As for size, Mr Dudley points to 50 projects in the pipeline. BP, he says, needs to produce about 2.1m barrels of oil equivalent a day to stay in the big five club. Excluding Russia, output has slipped towards that mark and is nearly 30 per cent lower than in 2009, but it should rise this year.

The overall message from BP’s head office is returns will improve, and that much of the share price underperformance has been because of uncertainty over the final Deepwater Horizon bill. There is no appetite on the board for BP to be bought.

Mega-deals do happen, but they are rare, complex and risky. The promised cost savings can prove elusive. A merger with Shell, for example, proposed by Lord Browne when he ran BP, could fall foul of a competition probe.

But the bigger barrier to a deal is the uncertainty over the final size of BP’s Deepwater Horizon liabilities because US legal proceedings have yet to reach a conclusion.

BP will be toxic to any would-be buyer, analysts say. It is hard to see, too, how Exxon’s management could do a better job of reshaping the company. Take away those uncapped liabilities and the sanctions cloud hanging over Russia, and BP is not in bad shape. There is little evidence of an “underlying” fall in output: the decline is largely because of asset sales.

For Exxon, there is the extra risk of a political backlash in the UK were it seen to be taking advantage of the legal battle in America to swoop. Exxon declined to comment, but does not seem to be thinking of a BP-size deal. Settle Deepwater Horizon and that could change. Right now, however, bolting on cheaper barrels could make more sense.

Rosneft stake could be problem for suitor

To mount a good defence, you need a poison pill. And BP’s stake in Rosneft, while not as toxic as its Deepwater Horizon legal bill, could keep predators at bay, writes Christopher Adams.

Relations between the west and Russia have been pushed to breaking point over the Ukraine crisis, so doing business with Moscow carries great risks.

BP’s 19.75 per cent equity stake in Rosneft has not been affected by western sanctions imposed on Russia. But for ExxonMobil, were it to attempt a takeover of BP, the UK major’s connection to the Russian state-controlled oil company could be a problem.

Sanctions bar US and European companies from supplying the technology and money needed by Russian companies to explore remote areas such as the Arctic, seen by many industry insiders as the next big unexplored oil frontier.

Washington, having restricted long-term dollar financing to Rosneft and forced it and Exxon to put their joint drilling campaign in the Kara Sea on hold, is unlikely to want a deal that hands the US company hundreds of millions of dollars a year in Russian oil earnings and dividend income.

Rosneft accounts for about one-third of BP’s oil production, at just over 1m barrels of oil equivalent a day. BP’s profit from Rosneft was $470m in the fourth quarter of last year, down sharply from the same period in 2013. BP expects to receive a dividend in July from Rosneft of about half the $693m it secured in 2014.- reported http://www.ft.com.